Beyond IRAs and 401(k)s: Smart retirement saving options

By Walter UpdegraveNovember 3, 2011: 10:18 AM ET

NEW YORK (CNNMoney) -- -- My company doesn't offer a 401(k). I invest the max in a Roth IRA, but I know that won't provide enough for retirement. I'd like to invest another $5,000 a year into some sort of retirement plan. What options do I have? -- Daniel J., St. Paul, Minn.

I've always considered it stupid and unfair that our patchwork-quilt of a retirement system makes it tougher to save for retirement if your company doesn't have a 401(k).

I mean, the IRS's recent announcement that the maximum 401(k) contribution has been boosted to $17,000 (or $22,500 if you're over 50 and are eligible to contribute the $5,500 catch-up) for 2012 is great news if you're in a plan that allows you to sock away the max.

But if you don't have access to a 401(k) -- or you're in a plan that sets a lower limit -- you may be hard-pressed to save anything close to the max on a tax-advantaged basis, even if you have the moola to do so.

After all, the other go-to retirement vehicle, the good old IRA, allows you to contribute only up to $5,000 (plus a $1,000 catch-up). And that limit hasn't budged since 2008.

Given the need to boost retirement savings in this country, this sort of disparity makes no sense to me. But that's not an issue I have any sway over. You'll have take it up with the folks in Congress who set the rules for retirement plans.

What I can suggest though, are some ways you may be able to make the best of this absurd situation.

First, two quick questions: Are you married? If so, make sure that your spouse is also maxing out a traditional or Roth IRA.

The amount your wife can contribute depends on a number of factors, including whether she's covered by a pension plan and how much you both earn. But at the very least, she should be able to do a non-deductible IRA, which can then be converted to a Roth IRA. This calculator can help you determine the maximum allowable IRA contribution for this year whether you're single or married.

Second question: Does any of your income qualify as self-employment income, say, from a business you own or independent contracting or freelance work?

If so, you may able to contribute up to $49,000 this year ($50,000 in 2012) to a SEP-IRA or solo 401(k) plan.

Actually, as I explained in an earlier column, a solo 401(k) can give you an even better chance to put away big bucks as you may be able to contribute both as a business owner and an employee.

If you answered no to these two questions, however, then your best shot at leveraging your saving effort is to give up as little as possible to the tax man by opting for tax-efficient investments. Essentially, these are investments that minimize ongoing taxable distributions and generate most of their return in the form of unrealized capital gains.

Granted, you won't get the same tax breaks that are available in 401(k)s, IRAs and the like. But by holding such investments for more than a year, you increase the odds that most of your gains will be taxed at the long-term capital gains rate, which currently tops out at 15% vs. 35% for interest and short-term capital gains. In effect, you can create your own tax-shelter by letting your gains compound for the long-term with minimal drag from taxes.

So what sort of investments am I talking about here?

To start with, tax-managed mutual funds, which are funds that use techniques like offsetting gains and losses or selling high-cost shares in order to hold down net realized gains and taxable distributions. Index funds, such as the ones listed on our MONEY 70 list of recommended funds, also tend to be highly tax efficient because they buy and hold the stocks of a benchmark, rather than trade frenetically in an attempt to beat the market (a strategy that, even if it works, can reduce tax efficiency by generating more frequent taxable distributions).

And then there are ETFs, or exchange-traded funds. The fact that most ETFs are index funds that trade like stocks on an exchange makes them inherently tax efficient. But they also have a unique method for creating and redeeming shares that can make them even more tax friendly than regular index funds.

Actively-managed mutual funds can also be relatively tax-efficient, as is sometimes the case with stock funds run by managers who keep portfolio turnover down. But even low turnover doesn't necessarily assure a smaller tax tab.

The best way to tell how much of a fund's return is going into the taxman's pocket rather than yours is to check its "tax-cost ratio," which you can find by plugging the fund's name or ticker symbol into Morningstar's quote box and then clicking on the "Tax" tab.

Two other types of investments are often touted for their tax benefits, but I'm not so keen on them. Variable annuities, for example, do have the advantage of allowing you to avoid paying taxes on investment gains as long as those gains remain within the annuity.

But I have two quibbles with VAs: first, they often come with onerous fees that can gobble up a good portion of your return expenses. Second, all gains are eventually taxed at ordinary income rates. Which means you may be converting long-term gains that would otherwise be taxed at no more than 15% into gains taxed as high as 35%. (Yes, that's also true of 401(k)s and traditional IRAs, but they have other advantages that compensate for that drawback.)

The other investment that's often sold as a tax-friendly retirement vehicle is variable universal life insurance. But as I noted in a recent column, these policies also have lofty fees and a number of other downsides that make them an inferior choice for retirement savings.

Who knows? Maybe Congress will come to its senses and pass some legislation that gives people without 401(k)s access to better tax-advantaged savings vehicles.

In the meantime, though, you'll just have to make the most out of the options that are out there.